LINE Q4 16 – Game off.

Reply to this post

Gaming could save LINE but the focus appears to be elsewhere. 

• LINE reported a difficult set of results which laid bare how difficult it will be to return to growth without expanding either its coverage of Digital Life or its user base.
• With the shares trading on 5.7x 2016A EV / Sales, I think that a return to rapid growth is required just for the shares to stand still.
• Q4 16A revenues / EBIT were JPY37.5bn ($332m) / JPY1.6bn ($14m) substantially missing consensus estimates of JPY38.7bn / JPY5.3bn.
• Even with a one-off charge against EBIT removed from the figures, LINE still missed consensus EBIT by 50%
• The lower profitability was primarily caused by marketing expenses, general and admin expenses all of which grew substantially more than sales.
• The main issue is that LINE is trying to change its business model from one based on stickers and games sold through its IM platform to one based on advertising.
• This is because revenues from stickers and games is beginning to decline in the face of competing services (like Facebook Messenger and WhatsApp) which offer similar content for free.
• Furthermore, RFM calculates that LINE’s current offering is not broad enough to return the company to real growth.
• However, it should be able to replace existing revenues should they decline to zero.
• When I look at LINE, I think it is capable of driving monetisation through the Digital Life services of Instant Messaging, Shopping and Telephony giving it total Digital Life coverage of 18%.
• I do not think that its Smart Portal is mature enough to give it credit for Social Networking or any other Digital Life segment that it is trying to address.
• Furthermore, its user base is pretty stagnant at 217m leading RFM to calculate that LINE could generate around $1.5bn in advertising revenues on an annual basis or $373m per quarter.
• During Q4 16 LINE generated $139m in advertising with content generating $193m giving $332m in total.
• This clearly shows that replacing content with advertising will only allow revenues to expand to $373m per quarter, some 12% above where the company is now.
• To return to growth LINE will have to successfully expand its coverage of Digital Life or start growing its user base once again.
• Growing the user base will be a major challenge as LINE has consolidated its focus onto the four countries of Japan, Thailand, Taiwan and Indonesia which considerably limits its scope.
• Hence, I think it will have to improve its Digital Life coverage which will be difficult given that the other segments of Digital Life are pretty well covered already.
• The one exception I see is Gaming and here there is an opportunity for LINE given its heritage in selling games through its platform.
• This is a big segment and if LINE can generate a thriving multiplayer gaming community, then I can see its revenues expanding once again.
• Unfortunately, of this there is no sign with much of the effort being places on other areas which to date have resulted in increased investments but no real revenues.
• To justify its valuation, LINE must start to grow again as 5.7x EV / Sales is way to high for a company with low growth and heavy investments hitting profits.
• I can see the valuation making a major adjustment downward from here.